Let your investment strategy decide mutual fund choice

Shruti Jain, Oct 12, 2008, 02.16am IST

Picking the right mutual fund out of more than 3,000 options in the market can be really tough. But if you decide your investment strategy and fit it to your personal goals, things get much simpler. A mutual fund scheme's investment strategy describes the fund manager's approach to building a portfolio. Most equity mutual funds fall into one of the three categories: index funds, actively managed funds and enhanced index funds. Within each strategy there are a wide range of options.

UNDERSTANDING THE DIFFERENCE

Index fund managers attempt to replicate the performance of a benchmark index, say BSE's Sensex or NSE's S&P CNX Nifty, by creating a portfolio that mirrors the composition of the chosen index. In other words, there is no effort to beat the index, merely to earn the same return. Index funds are also called passive funds due to their passive investing style.

Active fund managers seek to outperform the market as a whole and attempt to meet this goal with a combination of smart stock picking, market timing and asset allocation decisions. Enhanced index funds, not a commonly used term, fall somewhere in between the two. They aim to track an index, but also attempt to generate higher-than-market returns by straying from the index in order to take advantage of market timing, specific stock selections, and/or leverage. See the chart for a brief summary of all the three types of funds.

FITTING INTO YOUR PERSONAL GOALS

As with any financial decision, choosing an investment strategy largely depends on your personal goals, as well as other considerations, including the asset class you're investing in, fund management and operating costs, interest in tax efficiency and your risk tolerance. And you have plenty of choice. The mutual fund industry in India is still in a nascent stage, and new schemes are being launched almost by the day. Given the perplexing array of funds and schemes to choose from, it's imperative that you understand what suits you best and what will meet your financial goals.